Inside Markets — Positioning

The hedge fund community has reduced risk into the election with estimates of gross portfolio exposure (from last Friday) at its lowest level since March ’23. Long only clients have also reduced risk in recent weeks according to sell-side trading desks. Listed options skew and S&P futures positioning also suggests defensive positioning into election results. Low gross trading exposure and light long-only positioning suggests the near-term election-related ‘pain trade’ is aimed higher.

The aforementioned positioning dynamic suggests that markets are, at least partially priced for a contested election outcome. The reaction in markets would depend on the degree of contention with worst-case outcomes diving a short-term spike in implied volatility. Markets are not currently priced for a Democrat sweep, which makes that outcome another short-term risk scenario. Any outcome that suggests political gridlock will eventually encourage hedge funds to re-gross and long-only managers to add back exposure. While markets seem partially priced for a Republican sweep, that eventual outcome would likely drive further rotation into banks, Industrials, transports and Energy. A clean Republican sweep could also trigger a relatively violent rotation into small/mid-cap stocks at the expense of mega-cap Tech if bond yields pullback from highs. The backup in bond yields looks exhausted and Treasury prices remain deeply oversold with bullish technical signals in 5, 10 and 30 year tenors.